Commercial

Family Law – Property Settlements

A shareholder agreement is one of the most important documents a business owner will sign. Most are drafted with commercial and succession risk in mind. Far fewer are drafted with relationship breakdown in mind – and that gap can have serious consequences for co-founders, business partners, and the company itself when a marriage or de facto relationship ends.

The problem most shareholder agreements do not solve

When a relationship breaks down, the family law property settlement process reaches into every asset a party holds – including shares in a private company. A well-drafted shareholder agreement governs what happens to shares on a range of trigger events: death, insolvency, departure from the business, and sometimes divorce. But the interaction between those contractual provisions and the court’s powers under the Family Law Act 1975 (Cth) is rarely addressed explicitly, and the consequences of that omission can be significant.

The central tension is this: a shareholder agreement may restrict or control share transfers in ways designed to protect co-founders and the company from unwanted third-party entry. But the Family Court has statutory powers that can override those restrictions in certain circumstances. Understanding where those powers begin and end – and how to structure a shareholder agreement that minimises exposure – is essential for any business owner who is also married or in a de facto relationship.

Key shareholder agreement mechanisms and how they interact with family law

Pre-emption rights

Pre-emption rights – also called rights of first refusal – give existing shareholders the right to acquire shares before they can be transferred to an outside party. On a transfer of existing shares, pre-emption is a contractual provision rather than a statutory default under the Corporations Act 2001 (Cth), so it must be explicitly included in the shareholders’ agreement or the company constitution.

In a family law context, pre-emption rights are relevant in two scenarios. First, where the settlement requires one party to transfer their shares to the other, the recipient spouse may not be a party to the shareholders’ agreement and may trigger pre-emption obligations. Second, where the settlement requires a party to sell their shares to fund a cash payment to the other party, the pre-emption mechanism will govern the process and price at which that sale occurs.

A well-drafted pre-emption clause should address whether a court-ordered transfer constitutes a “transfer” for the purposes of the clause – and if so, whether the other shareholders’ pre-emption rights are enlivened, at what price, and over what timeframe.

Drag-along provisions

A drag-along clause allows a majority shareholder (or a defined threshold of shareholders) to compel minority shareholders to sell their shares on the same terms if the majority agrees to a sale of the whole company. The purpose is to prevent minority holdouts from blocking an otherwise agreed exit.

The family law dimension arises most acutely in the start-up and SME context, where one co-founder separates from their spouse and the non-business-owning spouse becomes entitled to a share of the equity value. If the business subsequently receives an acquisition offer, the drag-along mechanism may operate to compel a sale of the separating party’s shareholding – at a time and on terms that may not align with the property settlement timetable.

Conversely, where it is the separating party who controls the drag-along threshold, there is a risk they could use that right to force a sale before the settlement is concluded – potentially crystallising value in a way that disadvantages the other party. Injunctive relief under s.114 of the Family Law Act is the primary mechanism available to restrain such conduct pending settlement.

Buy-sell mechanisms

Buy-sell clauses – sometimes called shotgun clauses or put-call mechanisms – provide a structured exit pathway when shareholders cannot agree, or when a defined trigger event occurs. Common trigger events include deadlock, departure from the business, insolvency, and sometimes death or divorce.

Where divorce or separation is a defined trigger event, the clause typically gives the remaining shareholders (or the company) the right to acquire the departing shareholder’s interest at a formula price – for example, net tangible asset value, or a multiple of EBIT as determined by an agreed independent valuer. This can lock in a valuation methodology that differs from the fair market value approach used by the Family Court, with consequences for the overall settlement.

A buy-sell clause triggered by separation does not automatically bind the Family Court. The court retains discretion to make orders inconsistent with the clause where it considers it just and equitable to do so, particularly if the formula price materially undervalues the interest. Parties relying on a buy-sell clause to resolve the business interest component of their settlement should ensure that the valuation mechanism is defensible on fair-market-value grounds.

Section 90AE – the court’s power to bind third parties

Part VIIIAA of the Family Law Act is the provision that most concerns business owners and their co-founders. Under s.90AE, the court may make orders in property settlement proceedings that bind persons and entities who are not parties to the relationship – including companies, company directors, and co-shareholders.

What orders can be made?

Section 90AE(1) sets out specific orders the court can make, including an order directed to a director of a company or to a company itself to register a transfer of shares from one party to the other. This is the provision most directly relevant to business equity disputes – it empowers the court to compel share registration regardless of what the shareholders’ agreement or company constitution says about transfers.

Section 90AE(2) goes further, allowing the court to make any order that directs a third party to do a thing in relation to the property of a party, or that alters the rights, liabilities or property interests of a third party. The breadth of this provision is significant: it is not confined to share transfers and can extend to orders that restructure equity arrangements, vary loan accounts, or alter the rights of co-shareholders.

Critically, s.90AE(6) provides that an order made under the section overrides any Commonwealth, state or territory law, as well as any trust deed or written agreement. This means a shareholders’ agreement – however carefully drafted – does not provide an absolute shield against a court order under s.90AE.

The threshold conditions

The power is not unlimited. The court may only make a s.90AE order if three threshold conditions are satisfied:

• The order must be reasonably necessary, or reasonably appropriate and adapted, to effect a division of property between the parties;
• If the order relates to a debt, it must not be foreseeable that the order would result in the debt not being paid in full; and
• The third party must have been afforded procedural fairness – that is, they must have been given notice of and an opportunity to be heard on the proposed order.

The procedural fairness requirement is significant for co-founders and co-shareholders. It means that if one party seeks an order under s.90AE affecting the company or another shareholder, those parties are entitled to be joined to the proceedings and to make submissions before any order is made.

The discretionary considerations

Even where the threshold conditions are met, the court must consider a range of discretionary factors before making a s.90AE order. These include the tax implications for the parties and for the third party; the impact on social security entitlements; the administrative costs the third party would incur in complying with the order; and, critically, the economic, legal, and practical capacity of the third party to comply.

In practice, the discretionary considerations operate as a significant brake on the exercise of the power. Courts have been reluctant to make orders that would substantially disrupt the commercial arrangements of an innocent third party, impose significant compliance costs, or expose a co-shareholder to material financial prejudice.

The limits of the power – Commissioner of Taxation v Tomaras

The High Court’s decision in Commissioner of Taxation v Tomaras [2018] HCA 62 confirmed that the s.90AE power extends to Commonwealth entities – including the ATO – removing any doubt that the provision is constitutionally valid and wide in scope. In that case, the court held that s.90AE permitted substitution of a tax liability even against the Commonwealth, though it noted that orders adversely affecting the ATO or other public creditors would rarely if ever be appropriate in practice.

The decision confirms the breadth of the provision but also illustrates its limits. The High Court’s observation that adverse orders against creditors will “seldomly if ever” be made reflects a broader judicial approach of caution when third-party interests are genuinely at risk. For co-founders and investors, this means that while the power exists, it is not routinely exercised in ways that would materially harm an innocent commercial party who has acted in good faith.

A shareholders agreement cannot guarantee immunity from a s.90AE order – but a well-drafted agreement, combined with early legal advice, significantly reduces the risk that the court will need to exercise the power at all.

Section 90AE and the shareholders agreement – the override question

The most important practical question for business owners is this: if the court makes an order under s.90AE directing the company to register a share transfer, does that order override the pre-emption or consent-to-transfer provisions in the shareholders’ agreement?

The answer, under s.90AE(6), is yes – the order overrides any written agreement. This means that a shareholder agreement clause requiring the consent of all shareholders to any share transfer, or granting pre-emption rights on any transfer, does not prevent the court from ordering a transfer directly.

However, the threshold and discretionary conditions mean the court will typically consider whether the order is truly necessary in light of the contractual arrangements already in place. Where the shareholders’ agreement provides a workable mechanism for resolving the equity dispute – for example, a buy-sell clause with a fair valuation process – the court may be reluctant to override it. The practical implication is that a well-designed shareholder agreement buy-sell mechanism is not merely a commercial protection; it is also a factor that may influence whether the court exercises the s.90AE power at all.

Practical steps for business owners

Before a relationship breakdown – the proactive steps

The most effective protection is structural, and it is best put in place before any relationship difficulty arises. Business owners and co-founders should consider the following.

Review the shareholders’ agreement for family law exposure. Most agreements drafted by commercial lawyers do not address separation or divorce as a trigger event, and do not contain any provision regulating what happens to shares on a relationship breakdown. A review focused specifically on this question – ideally involving both a commercial and a family lawyer – should be on the agenda for any business owner who is also in a relationship.

Include a separation trigger and valuation mechanism. The shareholders’ agreement should address what happens if a shareholder’s relationship breaks down. Options include a right (but not obligation) for the company or co-shareholders to acquire the affected shares at a formula price, a requirement to notify co-shareholders of separation proceedings, and a valuation mechanism that aligns with fair market value standards – both to give the settlement process a clear reference point and to reduce the risk that the court will find the formula price inadequate.

Consider a binding financial agreement (BFA). Under s.90B of the Family Law Act, parties to a marriage (or under s.90UB for de facto couples) may enter into a financial agreement before or during the relationship that deals with the distribution of property on separation. A BFA can be used to ring-fence a business interest – for example, by providing that one party’s shares in the company are to remain their separate property on any settlement. BFAs must be carefully drafted and independently certified to be enforceable; advice from an experienced family lawyer is essential.

Align the shareholders agreement with the BFA. Where a BFA is in place, the shareholders agreement should be consistent with it. A BFA that ring-fences shares, in conjunction with a shareholders agreement that gives co-founders consent rights over any transfer, provides layered protection and reduces the likelihood that the court needs to exercise the s.90AE power.

After separation – the immediate priorities

Where a relationship has already broken down, and a business interest is in the property pool, the priorities are different.

Obtain an urgent asset preservation injunction if necessary. Where there is a risk that the other party will take steps to diminish or dissipate the business interest – including exercising drag-along rights, diluting equity through a share issue, or transferring assets out of the company – an application for injunctive relief under s.114 of the Family Law Act should be considered urgently. The court has broad power to restrain dealings in property pending settlement.

Notify co-founders and seek their cooperation. Where the shareholder agreement contains provisions relevant to the settlement – pre-emption rights, buy-sell mechanisms, consent requirements – co-founders and co-shareholders should be kept informed, and their cooperation sought. A consensual resolution under the existing contractual framework is almost always preferable to a contested s.90AE application that exposes them to the cost and disruption of being joined to family law proceedings.

Consider the valuation alignment question early. If the shareholders’ agreement contains a formula valuation for buy-sell purposes, it is important to assess early whether that formula will produce a result consistent with fair market value. A significant gap between the formula price and fair market value is a risk factor for both parties – it increases the likelihood of a contested valuation and may prompt the non-business-owning party to resist resolution under the contractual mechanism.

Co-founders and investors – protecting your position

A co-founder or investor who is not a party to a separating shareholder’s relationship nonetheless has a direct stake in how the family law proceedings resolve. The risk of an unwanted new shareholder, an s.90AE order disrupting the cap table, or the company being drawn into litigation as a third party are all real.

The most effective protection is a well-drafted shareholders agreement that addresses family law exposure explicitly. Beyond that, co-founders and investors who become aware that a shareholder is involved in property settlement proceedings should:

• Review the shareholders’ agreement immediately to understand what transfer and consent rights are in place;
• Obtain independent legal advice on whether they may be joined to the proceedings as a third party and what their rights are in that process;
• Engage constructively with the separating shareholder’s legal team to facilitate a resolution that minimises disruption to the company; and
• Consider whether any proposed orders under s.90AE adversely affect their interests to a degree that warrants making submissions to the court in the procedural fairness process.

The procedural fairness requirement in s.90AE(3) means co-founders and investors are entitled to be heard before any order affecting their rights is made. That entitlement should not be overlooked – the court’s exercise of its discretion is directly influenced by submissions from affected third parties.

Summary – the key questions for business owners

Any business owner in a relationship should be able to answer the following questions about their shareholders’ agreement:

• Does the agreement address separation or divorce as a trigger event?
• Do the pre-emption and consent-to-transfer provisions apply to a court-ordered transfer, and if so, what is the mechanism for resolving them?
• Does the buy-sell mechanism produce a price consistent with fair market value, and would a court be likely to accept it as a basis for settlement?
• Is there a binding financial agreement in place, and is it consistent with the shareholders’ agreement?
• Are the co-founders aware of the family law exposure and aligned on how a separation scenario would be managed?

If the answer to any of these questions is uncertain, a review is warranted – and it is considerably less expensive to conduct that review now than to resolve the consequences of an inadequate agreement in the context of contested family law proceedings.

This article is published by Koffels Solicitors & Barristers for general information purposes. It does not constitute legal advice and should not be relied upon as a substitute for advice specific to your circumstances. The law in this area can change. You should obtain independent legal advice in relation to any matter that affects you. © Koffels Solicitors & Barristers, Sydney NSW.